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Ref. No. KLI/22-23/E-BB/492
Inflation meaning is the rise in prices of goods and services over time, reducing the value of money. It affects your purchasing power, savings, and overall cost of living, making it important to understand and manage wisely. Understanding what is inflation is key to making informed financial decisions.
Inflation refers to the general increase in prices of goods and services over time, leading to a decrease in the purchasing power of money. In simple terms, you need more money to buy the same things you used to afford with less. The inflation definition highlights how rising prices can make everyday life more expensive.
One of the main causes of inflation is when the money supply in the economy grows faster than the supply of goods and services. This can happen due to central banks printing more money or commercial banks giving out more loans. As a result, more money chases the same number of goods, pushing prices up.
Inflation affects everyone as it can eat into your savings, raise the cost of living, and impact investment returns. That is why understanding the causes and effects of inflation is key to managing your personal finances and planning for the future.
The inflation rate shows how much the prices of goods and services have increased over a certain period, usually measured every month or year. It reflects how quickly prices are rising or falling, serving as a key indicator of economic stability.
Inflation Rate Formula
The inflation rate is calculated using the Consumer Price Index (CPI), which tracks changes in the cost of a fixed basket of consumer goods and services.
Formula:
Where:
How to Calculate Inflation Using CPI
To calculate inflation for a specific product or over a general period:
This calculated rate helps compare inflation across different timeframes and assess changes in purchasing power or cost of living.
This type of inflation arises when there is an increase in the supply of currency notes in circulation. An excess printing of money without a corresponding growth in goods and services can trigger currency inflation.
Credit inflation occurs when commercial banks extend more loans and advances than the economy requires. As banks increase credit availability to boost profits, the resulting excess money supply leads to rising price levels.
When government expenditures exceed revenues, resulting in a budget deficit, the government may request the central bank to print additional money to finance the gap. This injection of extra money into the economy causes prices to rise, leading to deficit-induced inflation.
Demand-pull inflation happens when aggregate demand in the economy surpasses the available supply of goods and services. This imbalance causes prices to rise as consumers compete for limited resources.
This form of inflation is driven by increases in the cost of production, such as higher prices for raw materials, labour, and other inputs. As production costs rise, businesses pass on these costs to consumers in the form of higher prices, leading to cost-push inflation.
Creeping inflation refers to a slow and steady increase in price levels, generally around 2% to 3% annually. This moderate rate is often considered manageable and can even be beneficial for economic growth by encouraging spending and investment.
Walking inflation occurs when the annual price increase ranges between 3% and 4%. It represents a higher but still moderate level of inflation that, if unchecked, can accelerate and lead to more severe inflationary pressures.
Galloping and Hyperinflation Galloping inflation refers to a rapid and uncontrollable rise in prices, often reaching double or triple digits annually. If it escalates further, it can result in hyperinflation—an extreme and destructive form of inflation that severely disrupts the economy and erodes the value of money.
Inflation can be either openly acknowledged or hidden, depending on government policies. Through various anti-inflationary measures, such as monetary tightening and fiscal discipline, governments strive to control inflation and minimize its adverse effects on the economy.
Inflation impacts different types of investments in varying ways. For fixed-income assets, such as traditional bonds, treasury bills, or certificates of deposit (CDs), inflation can erode returns. Since these instruments pay a fixed interest rate, rising inflation reduces the real value of those payments over time.
Equities, or stocks, may respond differently to inflation depending on the broader economic environment and the company’s ability to manage rising costs. During periods of economic growth with moderate inflation, businesses might experience higher sales and revenue, potentially boosting stock prices. However, inflation also increases expenses like wages and raw materials, which can compress profit margins. Ultimately, a company’s ability to pass on these costs to consumers will determine whether inflation benefits or harms its stock performance.
Historically, precious metals like gold have tended to perform well during times of high inflation, making them a popular hedge against inflation risk. Including gold or other commodities in your investment portfolio can protect you by preserving value when inflation rises.
Additionally, some investments are specifically designed to adjust to inflation. For example, certain floating-rate bonds and inflation-indexed annuities offer income that rises with inflation and falls when inflation slows, helping to stabilise real returns. These instruments often come at a premium but can provide valuable inflation protection.
An increase in the inflation rate impacts the economy in several significant ways beyond just reducing purchasing power:
Indicator of Economic Growth: Moderate inflation often signals rising demand within the economy, which can stimulate production and contribute to economic expansion.
Wage and Cost Pressures: As prices rise, workers may seek higher wages to maintain their living standards. This can lead to increased operational costs for businesses. If companies struggle to absorb these expenses, they may resort to layoffs, potentially raising unemployment levels.
Impact on Competitiveness and Currency Value: Higher inflation can make domestically produced goods less competitive in international markets due to rising prices. This loss of competitiveness may contribute to a depreciation of the national currency, affecting trade balances and foreign investment.
When managing investments, it is important to understand how inflation affects different asset classes. Broadly, investments fall into four categories: fixed income, market-linked instruments, commodities, and real estate. Each reacts differently to rising inflation and savings plans
Fixed income assets, such as bonds, fixed deposits, and recurring deposits, offer predetermined returns until maturity. Inflation erodes the real value of these returns, making fixed income investments less attractive during periods of rising inflation. Similarly, debt-oriented instruments like debt mutual funds are also negatively impacted as their returns do not typically adjust for inflation.
Equities and equity mutual funds are classic examples of market-linked investments. Over the long term, these assets tend to perform well against inflation because their returns often increase as inflation rises. This positive correlation makes equities a preferred choice for investors seeking to preserve and grow purchasing power over time.
Precious metals such as gold and silver have historically served as effective hedges against inflation, particularly in markets like India. While commodities generally track inflation trends favourably, their ability to outperform inflation tends to be lower than that of equities, especially in rapidly growing economies.
Real estate investments often appreciate over time, and moderate inflation can boost property values. However, the growth of real estate and related instruments like Real Estate Investment Trusts (REITs) depends on factors such as government policies and market demand, which can be adversely affected by high inflation. Therefore, the positive correlation between real estate prices and inflation holds only up to a point.
Given these dynamics, investors should strategically diversify their portfolios across various asset classes to generate returns that outpace inflation, while also managing overall investment risk and volatility.
To protect your wealth from inflation, it is important to invest in assets that offer returns higher than the inflation rate. One smart way to do this is by investing in equities, especially through diversified index funds that follow broad market trends. These are known to deliver strong long-term returns.
A balanced investment strategy, called asset allocation, can also help. This means spreading your money across different types of investments like equities, debt, real estate, and commodities, so you are not relying on just one area to grow your money.
Another key to beating inflation is starting early and staying invested for the long run. Even if markets go up and down in the short term, long-term investments benefit from compounding, and your earnings start earning returns too. So, by being consistent and informed with your choices, you can build an inflation-resistant portfolio and protect your future purchasing power.
The key differences between today’s inflation and historical inflation lie in their causes, complexity, and how they are managed.
In the past, inflation was often triggered by direct and visible factors like wars, poor harvests, or oil price hikes like the 1970s oil crisis. Back then, governments had limited tools to control it and mainly used interest rate hikes or strict monetary policies.
Today, inflation is influenced by a mix of global and interconnected factors. For example, after the COVID-19 pandemic, inflation was driven by supply chain issues, labor shortages, and massive government spending. The impact of technology, global trade, and shifting consumer behavior also plays a role in how inflation behaves now.
Modern central banks have more advanced tools, such as dynamic interest rates, real-time economic data, and strategies like quantitative easing to manage inflation more effectively. While inflation today can still be serious, it is often addressed more quickly than in the past.
However, because of how connected the world is, inflation now spreads faster across countries. A disruption in one part of the world can impact prices everywhere. So, while modern tools help, today’s inflation is more complex and unpredictable than before.
Inflation influences everything, from everyday spending to long-term investment plans. It is more than just rising prices; it is about how the value of your money changes over time. Be it shopping for groceries, saving for retirement, or planning investments, understanding inflation helps you make smarter financial choices.
By knowing what is inflation, what causes inflation, how it affects different investments, and how to build a strong portfolio, you can protect your savings and even grow your wealth. With the right knowledge and a well-planned strategy, you can stay ahead of inflation and secure a stable financial future.
1
Inflation is typically caused by increased demand for goods and services (demand-pull) or rising production costs (cost-push), along with factors like excess money supply and fiscal or monetary imbalances.
2
Inflation is measured using price indices like the Consumer Price Index (CPI) and Wholesale Price Index (WPI), which track changes in the cost of goods and services over time.
3
Consumer Price Index (CPI) measures retail inflation from a consumer’s perspective, while Wholesale Price Index (WPI) tracks wholesale price changes at the producer level before goods reach the end consumer.
4
Inflation affects interest rates, purchasing power, investment decisions, and overall economic growth, making it a key factor in economic planning and policy-making.
5
Inflation types include demand-pull, cost-push, currency inflation, credit inflation, and deficit-induced inflation, each driven by different economic factors.
6
As inflation rises, the value of money decreases, meaning you can buy fewer goods and services with the same amount, reducing your purchasing power over time.
Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.
Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors
In this policy, the investment risk in the investment portfolio is borne by the policyholder.
Kotak e-Invest
Features
Ref. No. KLI/22-23/E-BB/521
The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The content has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Further customer is the advised to go through the sales brochure before conducting any sale. Above illustrations are only for understanding, it is not directly or indirectly related to the performance of any product or plans of Kotak Life.
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